Last month, the European Commission formally requested that the government of the United Kingdom change two pieces of anti-avoidance legislation deemed incompatible with European Union law, in a move which could have far-reaching implications for investors and businesses who use foreign companies and other offshore structures to achieve tax optimization.
Opinion is divided among tax experts as to how much of an impact the Commission’s ‘reasoned opinion’ will have on UK tax law and people’s ability to minimize tax through the use of non-resident companies and trusts, but it is clear that some degree of change will happen and that wealthy investors and business owners will have to review their affairs to some extent. The infringement proceedings, issued by the European Commission on February 15, give the UK government two months to provide Brussels with a satisfactory response about what it intends to do to bring the rules into line with EU law, so any changes are going to be a few months down the line at least. If Whitehall intends to play hardball – and reports suggest that HM Revenue and Customs sees nothing wrong with the current rules – then change may not come for a number of years as the law in question is tested in the European Court of Justice. With much tax revenue at stake, the latter course is a distinct possibility.
The first infringement according to the Commission, relates to the UK's “transfer of assets abroad” legislation. Under this legislation, if a UK resident individual invests in a company by transferring assets to it, and if this company is incorporated and managed in another member state, then the investor is subject to tax on the income generated by the company to which they contributed the assets. However, if the same individual invested the same assets in a UK company, only the company itself would be liable for tax.
The second infringement relates to the attribution gains to member of non-UK resident companies regime. Under this legislation, if a UK-resident company acquires more than a 10% share of a company in another member state, and the latter company realises capital gains from the sale of an asset, the gains are immediately attributed to the UK company, which becomes liable for corporation tax on these capital gains. If, on the other hand, the UK company had invested in another UK resident company, only the latter would be taxable on its capital gains.
In both cases, the Commission considers there to be “discrimination,” because investments outside the UK are taxed more heavily than domestic investments. “The difference in tax treatment between domestic and cross-border transactions restricts two fundamental principles of the EU's Single Market, namely of the freedom of establishment and the free movement of capital contrary to Articles 49 and 63 of the Treaty on the Functioning of the European Union (TFEU) and Articles 31 and 40 of the EEA Agreement,” the Commission states. It is also of the opinion that the UK laws are “disproportionate,” in the sense that they go beyond what is “reasonably necessary in order to prevent abuse or tax avoidance and any other requirements of public interest.”
Warning that the UK may take pre-emptive action to avoid a referral to the Court of Justice, David Kilshaw, Chair of KPMG’s private client practice in the UK, suggests that any change to these pieces of anti-avoidance legislation could have a “profound impact” on the structure of UK tax legislation and how individuals operate their businesses and hold their investments.